Retirement Tax Hits Middle-income Payers

August 14, 2000

Should a family earning $60,000 to $70,000 a year pay taxes at a higher rate than a family with an income of two, three or four times as much? Thanks to Congress, that's what happens when they retire and start to collect Social Security, according to analysts.

Congress made up to 50 percent of all benefits taxable, then added a step that made up to 85 percent of all benefits taxable.

While it was described as a tax on high-income people, the law hits middle-income retirees.

This is because the tax is based on a formula that adds Social Security benefits to other sources of income.

Suppose a couple's dividend, interest and pension income rises from nothing to $100,000 -- including $22,000 in Social Security benefits, which is about what two average-income workers would receive. Here is what happens at different income levels:

At $15,000 in pension, dividend and income income, they owe $92 in income taxes; at $21,000, a portion of their Social Security benefits becomes taxable.

In effect, additional investment or pension income is surcharged, so the effective tax rate is 23 percent.

As other income reaches $35,000, the effective tax rate rises to 25 percent; as it rises to $50,000, up to 85 percent of their Social Security benefits become taxable, making their effective tax rate 42 percent.

However, over $50,000, each new dollar of income is taxed at only 28 percent, and other income can double to $100,000 before they start to pay taxes at a 31 percent rate.

As a result, the supposed tax on fat cats is really a tax on middle-income people who happen to be retired.